On Tuesday, September 28, 1999, an extraordinary spike in volume, volatility and price occurred in the gold options market at the Commodity Exchange, Inc. (“COMEX” or “Exchange”), a Division of the New York Mercantile Exchange (“NYMEX”). Responding to a Sunday, September 26, 1999 announcement by 15 European central banks of a surprise five-year moratorium on all new sales of gold from their reserves, the gold options market traded a record volume of 81,317 contracts in a record number of trades, 15,044. This was more than double the previous volume record of 39,944 contracts set on March 7, 1995, and a more than a twelve-fold increase over the normal number of trades. Gold options volatility also was unusually high. For example, the price of the December 1999 $300 gold call, the most active contract, had an extremely wide trading range. The premium fluctuated between a low of $5 and a high of $29 before settling at $18, up $15.30 for the day.1
The gold options market was severely strained on September 28 with respect to execution and clearance of orders. This was due primarily to the tremendous influx of small-lot paper orders to the floor throughout the day, and the myriad of option series and strike prices traded. As a result, the Division of Trading and Markets (“Division”) received a large number of complaints, 69 in all, predominantly from retail customers who had entered or attempted to enter small-lot gold option orders on September 28. The complaints, in large part, involved the status of possible unfilled orders, including market orders; long delays in reporting or confirming fills, or no reports at all; and an inability to place limit or other contingent orders. In addition, press reports alleged that on September 28 gold options floor brokers may have given preference to the execution of large orders, that thousands of small orders may have gone unexecuted, and that many retail customers were left uninformed for days of their market positions.
In light of the many complaints from the public and the allegations in the press, the Division subsequently undertook a study of gold options trading at COMEX on September 28. The Division reviewed various market participants’ activities of that date to determine whether orders were received and executed in accordance with relevant Exchange trading rules, whether clearing rules and procedures were observed, whether the events of September 28 revealed systemic problems, and what corrective steps, if any, should be recommended to ameliorate the impact of such market conditions should they recur.
In conducting its review, Division staff interviewed six floor brokers, officials at six futures commission merchants (“FCMs”), and COMEX compliance, legal, administrative, and operations personnel (collectively, “Exchange staff”).2 In addition, Division staff observed a demonstration of the Exchange’s On Line Trade Entry (“OLTE”) system, and obtained written information from Exchange staff on aspects of OLTE’s functioning significant to this review. Division staff also conducted a trade practice investigation of September 28 gold options trading to determine whether there were any indications of possible trading violations.3
The report that follows includes: (1) a discussion of the events of the week of September 28; (2) an analysis of the issues raised by those events; and (3) the Division’s conclusions and recommendations. It does not, however, contain analysis or findings regarding individual broker trading activity.
As noted above, on Sunday, September 26, 1999, 15 European central banks announced a surprise five-year moratorium on all new sales of gold held in official reserves. Prior to this announcement, gold prices had been pressured by worries about central bank gold selling, caused by a May 1999 British Treasury announcement of plans to unload more than half of its $6.5 billion in gold reserves in exchange for world currencies. The May announcement had triggered concern that governments and central banks would soon be dumping bullion reserves, flooding the market and driving prices lower. Gold prices had reacted by falling swiftly and sharply. By July 6, 1999, the August 1999 futures contract had settled at a 20-year low of $257.80 per ounce.
The September 26 weekend announcement by the central banks removed a major uncertainty surrounding gold sales. In a statement, the banks pledged that gold “will remain an important element in global monetary reserves” and vowed not to enter the market as sellers, except in cases for which a sale had already been agreed. They also announced that they would limit the amount of their gold lending. News sources reported that in light of the statement, the market knew exactly what would be available for sales and for lending for the next five years.4
On Monday, September 27, 1999, in response to the announcement by the central banks, gold options volume, which had averaged approximately 6,434 contracts during the first seven business days of September 1999, quintupled to 34,893 contracts,5 and gold options price volatility began to increase.6
Floor brokers, FCMs, and Exchange staff interviewed by the Division generally did not see in the events of September 27 any indication of what was to occur on September 28 in the gold options market.7 The floor brokers and FCMs viewed September 27 as a “busy day” which involved a volume increase, but was still somewhat within normal expectations. However, some floor brokers and FCMs experienced order routing and clearing difficulties which, as discussed below, may have been precursors of, or contributors to, the severe problems that arose the following day.
Specifically, several FCMs and floor brokers reported that the Trade Order Processing System (“TOPS”) electronic order routing system8 at COMEX malfunctioned at various times during the day on September 27. This resulted from problems with the TOPS link to the NYMEX building, where COMEX is located. Floor brokers stated that due to TOPS outages, order receipt was delayed for an hour or more during most of the day. Consequently, the normal timely execution of some orders was delayed. Some FCMs also reported receiving delayed fill reports from the floor on September 27.
Clearing difficulties also arose on September 27. Some floor brokers stated that, as the result of high volume and TOPS outages they found it more difficult than usual to reconcile trading card entries with order tickets and enter trades into OLTE. These brokers reported an inability to enter a significant number of their trades into OLTE before it was closed on the evening of September 27, despite the Exchange’s extension of OLTE input time to approximately 8:45 p.m. from its normal 5:00 p.m. close. One FCM with a significant share of gold options business reported that it did not receive data concerning outtrades from September 27 until approximately 10:00 p.m., several hours later than usual, and consequently had staff working all night to balance its books. As a result of these problems, before the opening on September 28, some floor brokers and FCMs had an unusually high number of unmatched trades from September 27.9
Exchange staff did not consider September 27 a problem day, although they did note the increase in volume. COMEX staff conducted routine market surveillance activities, including the review of large traders in gold options, and ascertained that variation margin payments were timely collected. Exchange staff did not view the number of outtrades on September 27 as a significant departure from the norm.
On Tuesday, September 28, 1999, the COMEX gold options market experienced a major market event, involving record volume, extraordinary price volatility, and significant problems with order execution, fill reporting, clearing, and implementation of order restrictions.
The floor brokers and FCMs interviewed stated that the number of orders sent to the floor on September 28 exceeded anything in their memory. As noted earlier, the number of gold options trades increased more than twelve-fold over normal levels, and trading volume increased more than eight-fold over normal levels. Floor brokers received an unusually large number of orders before the open, and encountered waves of new orders coming in by electronic transmission and telephone throughout the day. Most of this order surge consisted of small-lot orders in various option series and strike prices.10 Because the majority of these small-lot orders were received through the TOPS system, the amount of paper received by brokers was described as overwhelming. Telephone orders also poured in: brokers reported that all their phone lines were lit up constantly all day, and that customers who had not traded in years called them with orders.
Floor brokers could not physically handle the enormous volume of orders coming into the ring, even though they were present in greater numbers than on a typical day. On a normal trading day, as measured by the period from September 1 through September 10, 1999, an average of 28 floor brokers transact customer orders in the gold options ring. On September 28, 54 floor brokers, some from other futures and options trading rings, traded gold options contracts for customers.11 Even this doubling of floor broker participation, however, could not cope with the huge increase in the number of orders needing execution.
Floor brokers’ difficulties in filling the flood of orders on September 28 were further compounded by extreme price volatility. A review of the most active gold option contract, the December 1999 $300 call, illustrates how volatile market conditions may have contributed to unfilled orders and numerous outtrades.12 According to the Price Change Register for September 28, at the opening at 8:20 a.m. this strike traded between premiums of $5 and $7, up from the previous day’s settlement of $2.70. At 8:20:01 a.m., a “fast market” was declared.13 The fast market continued for virtually the entire trading session. The price of the $300 call quickly spiraled higher, reaching the $15 level at 9:30:10 a.m. The market then traded between $10 and $15 until reaching $16 at 12:37:38 p.m. By 1:11:30 p.m., the market had rallied to $21, and at 1:31:26 p.m. it hit $29, the high of the day. Prices dropped to $22 level by 1:33:09 p.m., fell to $12 at 1:59:08 p.m., and fluctuated between $11 and $18 during the last half-hour of trading. The contract settled at $18, $15.30 higher than the previous day’s settlement.
The extraordinary number of orders and extreme price volatility contributed significantly to problems with order execution. Some FCMs and floor brokers stated that thousands of gold options orders sent to the pit were not executed, although one FCM stated that most of its orders were filled. Most of the unexecuted orders were limit or “cancel and replace” orders, although some market orders also were not executed. One FCM stated that nearly 2,500 of its orders were not executed, mostly limit orders attempting to liquidate calls. One FCM said that in a few instances orders reported as executed in fact were not. For orders that were executed, FCMs and floor brokers interviewed by Division staff said they had received very few complaints regarding fill quality.
A fundamental cause of execution problems was the sheer number of orders coming to the ring. Brokers and FCMs reported that their clerks had to deliver multiple, foot-high stacks of orders to the ring almost constantly throughout the day. Brokers stated that they frequently had stacks of orders in each hand and each pocket, and could not physically handle additional orders brought to them. Moreover, these order stacks were not prioritized,14 because orders came so rapidly that clerks had no time to sort them by type of order or time of receipt.15
Brokers and FCMs also stated that the TOPS printers for the gold options ring were incapable of printing orders as fast as they were entered into the system. As a result, TOPS orders were behind between 40 minutes to an hour or more all day.16 This contributed to order execution delays. One floor broker group reported that, as a result of these problems, some orders were diverted to TOPS printers at the New York Board of Trade, and that some may have been either delayed or misplaced in the process of transporting them to the COMEX floor.
Brokers’ problems were compounded by the unusually high number of options contracts trading actively that day. According to the COMEX Daily Market Report for September 28, nine options contract months, comprising approximately 364 different strike prices, were available for trading. Floor brokers interviewed by Division staff reported that almost all of these strikes were trading actively on September 28. This combined with the absence of order prioritization and extreme price volatility to create extraordinarily difficult conditions for order execution. As one floor broker interviewed by Division staff observed, “September 28 is the one day in this business no one in the pit will ever forget.”
The FCMs interviewed by Division staff noted that on September 28, large numbers of fills were not reported by floor brokers to their customers in the normal course, leaving customers uncertain as to their positions in the market. This occurred because brokers and their clerks were occupied by the need to execute as many orders as possible in the face of overwhelming order flow. The steady stream of incoming orders made it difficult for floor brokers to take time to report fills either telephonically or by keying the requisite information into TOPS, and also forced them to delay order ticket endorsement.
One FCM with a large share of COMEX gold options business reported that many of its filled trades were not reported until Friday, October 1, 1999, and some were not reported until Monday, October 4, 1999 or Tuesday, October 5, 1999. Another large FCM reported that it did not obtain information on some fills until as late as Wednesday, October 6, 1999.
Market conditions also caused significant clearing problems, which persisted for a substantial period of time after September 28 and were a principal cause of the trade confirmation delays complained of by many customers. These clearing problems resulted from entry into OLTE of incorrect trade information. OLTE requires that both members involved in each trade enter complete information about the trade before the system will accept the trade as a matched trade. Erroneous or incomplete input by one or both members will cause either an unmatched or a miscleared trade.
COMEX had an exceptional number of unmatched trades in gold options on September 28. Unmatched trades occur either when one broker has not entered any information regarding his or her side of a transaction into OLTE, or when one broker enters information that is inconsistent with the opposite broker’s entry with respect to the opposite broker’s identity, the date, commodity, contract, quantity, or price of the trade, or (for options) the strike price and whether the trade is a put or call. During the more typical trading days of September 1 through September 24, 1999, COMEX averaged less than three unmatched gold options trades out of approximately 1,300 trades per day, for an average unmatched trade percentage of approximately 0.18 percent. In contrast, on September 28, 2,636 gold options trades out of a total of 15,044, or approximately 18 percent, were unmatched.17
COMEX also had an exceptional number of miscleared trades on September 28. Miscleared trades are those that match on all clearing criteria but are incorrectly cleared on one or both sides to the wrong clearing member. This occurs when a broker enters erroneous or incomplete information in the clearing member or customer account fields in OLTE. Miscleared trades caused the greatest difficulties for floor brokers and FCMs, and were the principal reason why an unusually long time was required to rectify clearing problems from September 28. Most FCMs interviewed by Division staff said their experience was that there were significantly more miscleared trades than unmatched trades from September 28, and that miscleared trades constituted the larger part of their clearing problems from that day. One FCM estimated that approximately 80 percent of its trades miscleared at other FCMs. Another FCM, whose principal COMEX business is as a primary clearing member (“PCM”)18 for floor brokers and local traders, said that on September 29 it not only received notice of more unmatched trades involving its guaranteed brokers than ever, but also had more miscleared trades than ever defaulted to it as a PCM.19
The Exchange attempted to help facilitate OLTE trade entry on the evening of September 28 by sending Exchange staff to assist floor brokers with the input process. However, floor brokers unanimously told Division staff that this well-intended effort unfortunately exacerbated the problem. According to the floor brokers, even though the Exchange staffers did their best, virtually all the data entries they made contained keypunch errors, due in part to Exchange staffers’ unfamiliarity with brokers’ handwriting. As a result, many of the affected trades did not match broker to broker, and even more were miscleared.
As part of their effort to enter as many trades as possible into OLTE on September 28, a number of floor brokers asked the Exchange to leave OLTE open for input and corrections past the normal 5:00 p.m. cutoff time. Exchange staff informed the Division that COMEX did keep the system open on September 28 until approximately 10:15 to 10:30 p.m., and similarly extended OLTE’s normal input hours for more than a week thereafter. Many brokers and FCMs said it would have been more helpful if the Exchange had left OLTE open longer, even for an hour or two.20 However, COMEX staff told the Division it is necessary to close OLTE no later than 11:00 p.m. to allow enough time for OLTE’s overnight processing cycle. OLTE must be reopened no later than 4:00 a.m., since the Eurotop 100 and Eurotop 300 contracts begin trading at 5:00 a.m. the next trading day. COMEX staff also noted that delay in closing OLTE for the evening would have caused problems for many FCMs, who rely on final clearing data from COMEX in their own overnight data processing cycles, and face similar world-wide start-up deadlines for the next day’s trading.
Exchange officers and staff also discussed internally, in part at the suggestion of a few COMEX members, the possibility of delaying the opening of gold options trading on Wednesday, September 29, in order to allow time to reduce the number of unmatched trades. However, the Exchange decided that a delay would not be in the best interest of either the trading public or the Exchange, particularly in the world gold market situation then existing. The majority of FCMs and floor brokers interviewed by the Division concurred in this decision.
Beginning at some point on September 28, many gold options brokers began accepting orders of various types only on a “not held” basis.21 By September 29, and for approximately a week thereafter, virtually all brokers restricted the type of orders they would accept to market orders, and refused “cancel and replace” orders other than “replace to market.” Floor brokers interviewed by Division staff varied as to when they imposed order restrictions: one broker group notified its major FCM customers prior to the opening of trading on September 28 that it would take orders only on a not held basis, while another broker group first gave this notice to its customers on September 29. Shortly after September 28, both these broker groups restricted the orders they would accept to market orders only, one doing so on Wednesday, September 29, and the other on Thursday, September 30. One group did not lift this restriction until October 11, 1999. Most FCMs passed these restrictions on to customers through messages on proprietary electronic order entry systems, by fax and telephone calls, and by recorded messages on telephone lines used by their customers to place orders.
Virtually all the FCMs and floor brokers interviewed told Division staff that, in hopes of speeding resolution of both unmatched and miscleared trades from September 28 and the days immediately following, they asked the Exchange to hold a special weekend session to resolve those clearing problems. The Exchange has authority to do this under COMEX Rule 4.87.22 Brokers and FCMs stated that with mandatory attendance, to insure that all the people from whom information to correct a clearing problem was needed were available, and OLTE access, to allow correction in the clearing system, such a “disaster recovery” session would have allowed most clearing problems to be resolved.23
The Exchange considered this request, but decided not to call such a session.24 As noted by Exchange staff in their interview with Division staff and in an Exchange letter to the Division dated January 13, 2000, the principal reason for the Exchange’s decision was that the Exchange feared that problems with OLTE could result. Although OLTE had been used as the Exchange trade processing system since February 1988, it had never been opened except for normal trading days. The system had never been tested to determine what might happen if it was opened for corrections on a day when there was no trading. Exchange staff thought it was possible that opening OLTE on a non-trading day might cause COMEX to be unable to open in a timely and fully functional way on Monday, October 4, at a time when volatile market conditions still existed. Exchange staff found this risk unacceptable.
The FCMs interviewed by Division staff generally agreed, despite having each endured their share of execution problems on September 28, that the gold options floor brokers generally performed acceptably under the circumstances of the day in executing as many orders as they could. Floor brokers and FCMs interviewed by the Division agreed that the gold options pit was understaffed for handling the order volume seen on September 28. They also agreed, however, that the pit was appropriately staffed for the level of gold options trading seen during the four or five years preceding September 28, and that it would be economically infeasible to staff routinely for market events which occur as rarely as the events of September 28. This conclusion appears reasonable. As noted earlier, the number of floor brokers participating in gold options trading for customers on September 28 nearly doubled over normal levels. Exchange staff told the Division that the Exchange plans to request that floor brokers and FCMs develop contingency plans for added staffing in emergency situations like September 28 wherever possible. Although such plans are unlikely to prevent similar problems entirely in the future, they may be of some help.
Some customers alleged that large institutional orders received execution priority over smaller retail orders. The floor brokers and FCMs interviewed by the Division stated that few institutional orders were received on September 28, most institutional customers having reacted to the September 26 central banks announcement on September 27.25 There appears to be no indication that institutional customers received preferential executions. It is possible that in instances where floor brokers received orders by telephone from customers with whom they had ongoing relationships, some such telephone orders could have received priority over orders received on paper. However, floor brokers and FCMs reported that, regardless of how orders were received, the sheer number of orders made perfect prioritization of orders extremely difficult. As noted earlier, brokers’ and firms’ clerks did not have time to sort orders by type of order or time of receipt, since they were being overwhelmed by the flow of orders.
In situations where exceptional numbers of orders are received, there are several possible steps which the Exchange could take. Order deck prioritization problems can be alleviated through the use of electronic deck management systems, or other advanced technologies that may be available or appropriate for development, capable of sorting order decks instantly and continuously. Examples of order deck management systems currently in use at various domestic futures exchanges include the Electronic Clerk (“EC”) at the Chicago Board of Trade, the CME Universal Broker Station (“CUBS”) at the Chicago Mercantile Exchange, and the Lind-Waldock Order Book Management System (“LOBMS”), Lind-Waldock & Company’s proprietary system. These systems use small, stationary, wired terminals in the ring to receive orders. They organize the orders for execution, transmit fill information to the customer and the clearing member, and in some cases, simultaneously transmit trade information to the exchange clearing system. The Exchange has told the Division that it has now approved three pilot projects testing the use of different types of such devices. Early adoption of an electronic deck management system or similar technology by the Exchange would be an important step toward limiting problems like those of September 28 in the future.
The Exchange could also consider ways in which to ensure that dual trading members meet their obligations to fill executable customer orders before trading for their own accounts.26 When the capacity of the floor to execute orders is being exceeded, a question arises as to the obligation and practical ability of a broker to ascertain whether he has executable orders in his possession. Temporary trading halts could be one way to address this problem. The Floor Committee has authority to halt trading for up to an hour under Exchange rules.27 Implementation of trade suspension authority in situations like September 28 may require steps to ensure that the Exchange is made aware on a timely basis of the fact that order flow is exceeding execution capacity.
Another method of handling large numbers of orders can be side-by-side trading. In the event that the Exchange were to adopt such trading on its current NYMEX ACCESS® electronic trading system or a similar system, that system could serve as an outlet for execution of small orders that could not immediately be executed in the pit due to circumstances similar to those of September 28.
Lastly, TOPS system outages and the slow speed of TOPS printers caused substantial delays in orders reaching the gold options floor. Additionally, one firm rerouted orders to TOPS printers in other locations, and these orders may have been delayed or misplaced in the process of transporting them to the COMEX floor. Steps toward TOPS malfunction prevention, TOPS printer speed upgrades and installation of additional TOPS printers, and contingency plans for delivery of rerouted orders from other TOPS printer locations would also be useful in future situations involving exceptional numbers of orders.
Many customer and introducing broker complaints concerned their inability to ascertain the status of their orders. As noted earlier, fill reports were delayed on September 28 because floor brokers and their clerks gave first priority to accepting and filling executable orders, and as a result lacked time to report fills either telephonically or via TOPS. The Division believes that the brokers’ decision to give order execution the highest priority was appropriate. However, the resulting delays alarmed customers, who had become accustomed to receiving fill reports within minutes of order execution. Fill reporting delays continued after trading closed on September 28, in some cases for days. Many customers also complained that they had not received confirmation statements reflecting fills reported to them from September 28. FCMs and brokers told the Division that customer communication issues of this type resulted in large part from the magnitude of the miscleared trade problem, discussed below.
Gold options customers who did not receive fill reports or did not see their trades listed on their confirmation statements faced the possibility of a double fill if they reentered the market. FCMs took disparate approaches in dealing with these customers. On the morning of September 29, one FCM which has a major share of retail gold options business at COMEX found that it had not received fill reports for approximately 3,000 orders placed on September 28. This FCM decided to inform its customers immediately that: (1) if they had not already received a report of a fill, they should consider their order “unable,” and (2) they could reenter the market if they desired, and would not be held to the first order if, in fact, it was later discovered that it had been filled. In other words, this FCM swiftly advised its customers that the customers would not be held liable for possible double fills. The same approach was also taken by another FCM, which sent a memo to customers on September 29, advising them that if they had not already received a fill on orders that were executable, they should assume they were “unable,” and the FCM would not later “stick” them with a fill, resulting in a double fill in their accounts.
Another large retail FCM, which reported having several hundred unfilled orders, took a different approach. The FCM told customers inquiring about the status of their orders that a report on their orders had not been received by the firm, and that it would pursue the disposition of their orders. The FCM did not advise its customers that they would not be liable for possible double fills if they reentered the market.
Notwithstanding this disparate treatment, ultimately most customers were adjusted. FCMs interviewed by Division staff reported receiving varying numbers of customer complaints resulting from trading on September 28. Formal complaints, whether oral or written, ranged from approximately 50 at one large FCM to two or three at others. FCMs generally reported making financial adjustments for many customers, and assisting a few with the arbitration process. Most FCMs appear to have resolved most customer complaints in one of these fashions in a timely manner. This is borne out by the fact that as of February 1, 2000, the Commission had received only one reparations filing regarding COMEX gold options trading on September 28, and the fact that as of the same date, COMEX had received only three filings for Exchange arbitration on this subject.
As noted above, many of the delays in confirming fills to customers were connected to delays in trade data entry and clearing. The Division believes, based on the interviews it conducted with floor brokers and COMEX staff, as well as with FCMs, that FCMs generally used due diligence to work through the clearing problems that arose in connection with September 28 trading.28 Many FCMs reported that their staff worked extensive extra hours on September 28 and during the rest of the week that followed in order to deal with clearing problems, some working nearly all night and sleeping in the office rather than going home. FCMs with multiple offices brought in additional staff from offices in Chicago and elsewhere (in the case of one FCM, even from London, England).
Despite these efforts by FCMs, however, significant clearing problems regarding September 28 trades persisted for days, and in many cases weeks. The Division’s interviews with relevant parties, including Exchange staff, revealed that OLTE limitations contributed greatly to these problems. Certain Exchange policies, decisions, and rules also contributed to the delays. As noted above, these clearing problems involved both unmatched trades and miscleared trades.
As noted above, COMEX had 2,636 unmatched gold options trades on September 28 (as compared with a normal average of less than three), which amounted to approximately 17.52 percent of all gold options trades for the day. This exceptional level of unmatched trades contributed significantly to the trade confirmation delays complained of by many September 28 gold options customers.
As previously stated, unmatched trades occur either when one broker has not entered any information regarding his or her side of a transaction, or when one broker enters information inconsistent with the opposite broker’s entry as to the transaction’s “matching criteria.” These include the opposite broker’s identity, the date, commodity, contract, quantity, and price of the transaction, and (for options) the strike price and whether the trade is a put or call.
The fundamental cause of the unmatched trade problem was the tremendous number of trades with which floor brokers had to deal. Brokers correctly made executing as many trades as possible their first priority, and accordingly could not devote adequate time to allocating trades among orders and entering information into OLTE during trading hours.29 This meant that when trading closed, many brokers and clerks faced the task of gathering trade information and making OLTE entries for greater numbers of trades than they could process before OLTE was closed for the day. Brokers nevertheless were under great pressure to attempt to process all their trades, because at COMEX brokers cannot enter trades into OLTE after the day a trade is executed (referred to as “top-day” at COMEX).30 Such delays in trade processing are of concern because, among other things, they can be conducive to customer order misallocation abuses, and can also impede the placement of fills with the proper clearing members, as discussed below.
Some unmatched trades were caused by failure of one side to enter the trade at all. Many others were caused by keypunching errors, which were more prevalent than usual in the ordinary course of business due to the exceptional number of trades and the long hours worked by relevant staff. As noted earlier, the number of keypunch errors was further increased by the inexperience of temporary clerks provided, with good intentions, both by the Exchange and otherwise.
Resolution of unmatched trades requires labor-intensive and time-consuming work on the part of brokers and their clerks. When a trade is listed as an outtrade or break on the Daily Broker Recap (“DBR”) report a broker receives from the Exchange, it is not readily apparent to that broker which aspect of the trade information, or even which party, has caused the break. Rather, the broker must closely examine all of the entries and often must also review the underlying trading cards and order tickets.
Despite the exceptional number of unmatched trades from September 28, during the week that followed the COMEX system appears to have worked as designed to resolve a large part of the unmatched trade clearing problems from that day. As noted earlier, under COMEX Rule 4.86(b)(2) (the “four-day rule”), unmatched trades from September 28 had to be resubmitted with corrected data for proper clearing no later than October 4, 1999, the fourth business day after September 28. For 96 percent of September 28’s unmatched trades, this deadline was in fact met.
The Division’s review of the COMEX Final Unmatched Trade Report dated October 4, 1999, which covered September 28 trading, showed that by October 4, all but 103 trades (involving 399 contracts) out of the 2,636 trades (involving 17,552 contracts) unmatched on September 28 had been resolved. This accomplishment was facilitated by the decision of Exchange officials, on Thursday, September 30, and Friday, October 1, 1999, to restrict a total of eight floor brokers with large numbers of unmatched trades from further trading in the ring until they had resolved their unmatched trades.31
As noted earlier, COMEX also had an exceptionally large miscleared trade problem with respect to September 28 trades. The miscleared trade problem caused the greatest difficulties for floor brokers and FCMs, and was the principal reason why an unusually long time was required to rectify clearing and fill reporting problems.
Miscleared trades occur when a broker inputs trade information that identifies the wrong clearing firm or does not conform to the terms of any order placed with that broker by the identified clearing firm. In such cases, the clearing member receiving the trade usually will contact the executing broker to determine whether the trade was mistakenly assigned to it, and if so will reject or “DK” (meaning “don’t know”) the trade in OLTE during the day.32 This has the effect of reassigning the trade to the PCM, the clearing member that has agreed to guarantee unconditionally all of a broker’s trades, unless the broker reallocates the trade to the correct clearing member during the day. Typically, a PCM will hold a miscleared trade for a broker for a limited time in order to allow the broker to determine the correct clearing member. If the correct clearing member is not determined, the PCM will place the trade in the broker’s personal account at the PCM. In cases where an assignment error is not found until after the close of OLTE for the day, the trade will be cleared to the clearing member to which it was mistakenly assigned.
Trades miscleared on September 28 for a variety of reasons. Some FCMs told the Division they believed that many September 28 trades miscleared because brokers attempted to input as many trades as possible that would match with their opposite parties, and simply assigned trades to the clearing member for whom they did the most customer business. Under COMEX Rule 4.82(a), to process a trade fully and properly, a floor broker must enter into OLTE not only the required matching criteria but also the identity of the clearing member and the customer account in which the trade will clear.33 Brokers or their clerks normally gather the requisite information during the trading day, by locating and matching up trading cards (which contain the matching criteria data) and order tickets (which show the clearing members and customer account numbers involved). However, on September 28 many brokers and clerks could not gather the needed clearing member and customer account information, due to the need to execute as many trades as possible and the enormous quantity of paper remaining to be processed after trading ended.
Because PCMs are financially responsible for all trades by the brokers they guarantee, they generally limit the number of unallocated or misallocated trades they will hold for a broker at one time, and may suspend the guarantee of a broker who exceeds that limit until the broker reduces the number of such trades. A few FCMs speculated that brokers could have assigned trades to the wrong FCM in an attempt to avoid such suspension of their guarantees, at least temporarily. Brokers interviewed by the Division acknowledged that many of their trades were assigned to the wrong clearing member, but stated that this was unintentional. They said that miscleared trades were caused by such factors as the need to process an enormous number of orders before OLTE closed, the inexperience of temporary workers, and the difficulty of properly sequencing and allocating the large number of wire-house orders from the day. Both FCMs and brokers stated that clearing members may have been mistakenly identified in some cases through erroneous assignment of all the lots in a multi-lot trade to one clearing member when the trade actually included lots for multiple clearing members.34
Finally, trades also miscleared because brokers assigned them to the specially designated allocation accounts, known as “ALLO” accounts, maintained for each broker in OLTE to facilitate the broker’s handling of bunched orders.35 A broker can place a trade into his ALLO account by temporarily identifying his PCM as the clearing member for the trade, and identifying “ALLO” as the customer account. This allows the broker to input information to match a bunched order with the opposite broker, while waiting to input the necessary multiple allocations to customer accounts until later in the day. Exchange staff, FCMs, and some floor brokers informed the Division that on September 28 some floor brokers used ALLO for significant numbers of trades, including many un-bunched orders, in order to save time and thus enable execution and clearing of more orders. However, since these brokers lacked time to replace the ALLO information before OLTE closed for the day, these trades miscleared to their PCMs.36
The miscleared trade problem from September 28 was compounded by the fact that many more trades than usual were cleared at wrongly-identified clearing members. As noted above, under normal market conditions most improperly assigned trades are rejected by clearing members during the day as “DK” trades. However, many clearing members did not have the resources to identify and “DK” the large numbers of misdirected trades they received on September 28. Clearing members were particularly likely to retain trades of which they were unsure if they frequently used the services of the assigning floor broker.
When a trade has been mistakenly cleared at a PCM or an incorrectly identified clearing member, getting the trade reassigned to the correct FCM requires action by both clearing members. The trade must be cancelled in OLTE by the house in which it cleared erroneously and accepted in OLTE by the correct house. FCMs and floor brokers told the Division that in the aftermath of September 28 the process of resolving miscleared trades was extremely difficult and time-consuming. The numbers of miscleared trades needing attention far exceeded anyone’s previous experience. Because trading was still busier than normal between Wednesday, September 29, and Friday, October 1, floor brokers and FCMs had limited time to deal with miscleared trades from September 28. Although many clearing members made additional staff available to assist brokers in resolving miscleared trades (as well as unmatched trades), because so many brokers needed assistance from the same clearing members, they were forced to wait on long lines for assistance on a rotating basis. Limited resources and the need to be equitable required clearing members to give each broker only a brief period of attention before working with the next broker in line. The fact that only FCMs, and not brokers, can input correction data into OLTE after top-day appears to have delayed correction entries significantly.
Exchange staff indicated to the Division that the Exchange takes an active role in compelling early resolution of unmatched trades, but does not normally get involved in resolution of miscleared trades. This is because the COMEX clearing system treats trades as cleared if they have matched broker to broker, whether or not they have cleared through the correct clearing members. Accordingly, the Exchange views resolution of miscleared trades principally as a responsibility of the clearing members and floor brokers involved.
Nevertheless, on October 14, 1999, the Exchange sent a letter to the nine clearing members who originally had the largest numbers of unmatched gold options trades from September 28. The letter, among other things, reminded these clearing members of the due diligence requirement of COMEX Rule 4.86 regarding not only unmatched trades but also trades “that matched but are otherwise unreconciled,” i.e., miscleared trades. On October 25, 1999, the Exchange sent a second letter to the same firms, requesting information which in part concerned the miscleared trade problem at those firms.37
The Division believes that it was appropriate for the Exchange to attempt to address the problem of miscleared trades, although in the Division’s view the Exchange’s letters should have been sent at an earlier stage of the problem and addressed to all Exchange members and member firms. The Division also believes that both letters, and particularly the October 25 letter, show that the Exchange did not have enough information to enable it to determine either the extent of the miscleared trade problem from September 28 or the location of the remaining miscleared trades. In short, the Exchange was moving, albeit belatedly in the Division’s view, to obtain data on the miscleared trade problem, but had to go to member firms to do so.
The Exchange’s lack of information concerning miscleared trades may be of little consequence on normal trading days, but can seriously hamper recovery from major market events like the one that occurred on September 28. If the Exchange had a mechanism for gathering information on the extent and location of miscleared trades, it could address the problem at an earlier stage and give FCMs assistance in resolving such trades. This would help to minimize the impact of the miscleared trade problem on both Exchange members and customers.
Both brokers and FCMs criticized the functioning of OLTE and indicated a belief that additional OLTE input time on the night of September 28 would have helped resolve clearing issues in a more timely manner. Brokers stated that the enormous number of trades that day made input of significant amounts of trade data into OLTE before its closure that evening impossible. Although the Exchange kept OLTE open later than usual on September 28 and for several succeeding days, the additional time was inadequate to permit complete and correct input of the large amount of trade data needing entry.
The Exchange reported that it could not delay closure of OLTE further than it did on September 28 and the ensuing days, because OLTE must be closed in time to allow processing of each day’s business. Undue delay would impact the next day’s trading of Eurotop contracts, which open at 5:00 a.m., and interfere with FCMs’ overnight data processing cycles. While it is clear that additional delay in closure of OLTE on September 28 and subsequent trading days would have helped alleviate clearing problems, the Division agrees that overnight data processing was essential to the next day’s trading.
Many FCMs and floor brokers also asked the Exchange to hold a special weekend “disaster recovery” session to resolve clearing problems from September 28. They requested that the Exchange allow access to OLTE during this session and make attendance mandatory for all Exchange members. The Division believes that calling such a session could have been an effective step toward earlier resolution of the severe miscleared trade problem, as well as the remaining unmatched trades. However, the Exchange had never tested the effect of opening OLTE for correction input other than during a trading day. Exchange staff believed it would be imprudent to open OLTE on an unscheduled basis, because doing so could risk an OLTE malfunction during the following trading day.
COMEX staff has informed the Division that by mid-2000 the Exchange plans to move clearing at COMEX onto the Trade Management System (“TMS”) already used for clearing by NYMEX. The Exchange plans to provide holiday or weekend system capabilities through TMS for use in “disaster recovery” for events like those of September 28. Weekend or holiday access to enter corrections would be enabled, although corrections would not ultimately be processed until the next normal trading day. This would allow what FCMs and floor brokers requested following September 28, namely non-trading-day processing of corrections work which would otherwise have to be done during a trading day. In addition, because FCMs will have real-time access to TMS, they would be able to see the effects of corrections immediately and have access to interim hard copy reports.
Input into TMS will be single-sided and performed by Exchange staff rather than by broker’s clerks. Having input done by Exchange staff will reduce trade information processing demands on floor brokers. Exchange staff will input the sell-side trade data. The single-sided entry feature of TMS will eliminate unmatched trades by force matching the buy-side data to the selling broker’s data. The Division notes, however, that use of TMS will not eliminate the problem of miscleared trades, or reduce the need for greater Exchange focus on that problem.
The Division believes that using TMS for clearing at COMEX will contribute to the Exchange’s ability to handle future market events like September 28 more effectively. The Division also believes that the Exchange should take all possible steps to insure that TMS can provide holiday or weekend “disaster recovery” capabilities as discussed above, and in the event of another such market event should hold a mandatory “disaster recovery” session on a weekend or holiday to address clearing problems.
Some complaints to the Division by COMEX gold options customers concerned the fact that orders were being accepted only on a not held basis. These complaints show that some gold options customers were unaware that a floor broker might in some circumstances be not held, or uncertain of what this might mean.
Some customer confusion about not held orders may derive from misunderstanding among market participants about the meaning of the fast market light or fast market designation by the Exchange. Fast market conditions existed in the COMEX gold options market during most of the day on September 28.38 Some FCMs understood that when a fast market is declared, floor brokers are not held on all orders.39 These FCMs mistakenly believed that orders were not held all day on both Tuesday, September 28 and Wednesday, September 29, on this basis. Brokers agreed the floor has many different understandings of what the fast market light means.
Exchange staff reported receiving a number of inquiries on September 29 and 30 concerning the fast market and whether the Exchange had decided that brokers were not held on September 28. The Exchange replied to these inquiries by telling inquirers that it had not made any such decision, and that the fast market light does not indicate that floor brokers are not held, even though floor brokers frequently make a business decision to accept orders only on a not held basis during fast markets, when the risk of being unable to execute an order is necessarily greater. The Exchange also was queried about whether the floor committee had ruled that brokers were not held on September 28. Exchange staff verified with the committee that it had not made such a ruling.
Customer misunderstanding regarding the meaning of an order being not held may also derive from the confusing nature of the Exchange’s rules concerning not held orders. Three COMEX rules relate to this subject. COMEX Rule 4.07 defines the standard orders accepted at COMEX, including market orders, limit orders, specified time orders, stop orders, market-if-touched orders, and time and price discretion orders. COMEX Rule 4.08, which is labeled as the Exchange’s not held rule, provides that orders not defined in Rule 4.07 are always accepted on a not held basis. The rule which functions, in practice, as the Exchange’s not held rule is COMEX Rule 4.65 on “Exercise of Due Diligence.” This rule provides, in pertinent part, that a floor broker is not held responsible for failure to execute orders defined in Rule 4.07 if he has exercised due diligence in his efforts to do so. As a result, COMEX Rules 4.08 and 4.65, taken together, make a floor broker not held with respect to all orders, so long as he uses due diligence. This appears contrary to the general industry practice that a broker who wishes to be not held should inform his customer that he is accepting the customer’s order on a not held basis.
The Division believes that, in order to reduce member and customer confusion regarding not held orders, the Exchange should take two steps. First, the Exchange should revise its rules relating to not held orders, both to clarify them in form and to define properly the characteristics of not held orders. One way to do this would be to model the Exchange’s rules on this subject on NYMEX Rule 6.15(H) on “Not Held Orders” and NYMEX Rule 6.16 on “Obligations Of Floor Brokers.” NYMEX Rule 6.15(H) provides that if a trading member obtains agreement from the customer prior to accepting an order that it is being accepted only on a not held basis, the trading member is not responsible for failure to execute the order, absent fraud or willful misconduct. Orders other than not held orders are covered by NYMEX Rule 6.16, which applies a due diligence standard to executable orders, and a negligence standard to contingent orders. Second, the Exchange should clarify to its members and member firms the relationship of its rules concerning fast markets and not held declarations.
Some COMEX gold options customers who complained to the Division also stated that they had been told that on September 28 and for more than a week thereafter restrictions had been imposed on the types of orders being accepted for execution. In particular, many customers complained that only market orders were being accepted. Some customers said they were told that the Exchange had imposed these restrictions; others reported being told that FCMs or floor brokers had imposed them. The complaints to the Division, and also a substantial number of telephone calls on this subject received by the Exchange, demonstrate that a significant number of gold options customers were either unaware of, or confused by, circumstances in which it could be permissible for floor brokers to refuse certain types of orders, particularly when a customer is trying to liquidate a position.
Responding to a query from Division staff, the Exchange stated in a letter to the Division dated January 10, 2000, that COMEX rules neither require a floor broker to accept a particular order nor explicitly permit a broker to decline an order. During the Division’s interview with Exchange personnel, COMEX staff stated that a floor broker has the authority to decide what type of orders he or she will accept in given market conditions, and that the Exchange does not, and did not, involve itself in these decisions.
In this connection, Commission Regulation 1.55, which concerns risk disclosures to customers by FCMs and introducing brokers, requires, among other things, disclosure that (a) it may be difficult or impossible to liquidate a position under certain market conditions, such as when a market reaches its daily trading limits, and (b) contingent orders may not limit losses to intended amounts because market conditions could make their execution impossible.40 Regulation 1.55 does not, however, require specific disclosure that floor brokers or FCMs can refuse to accept certain types of orders in certain market conditions. Accordingly, the Division will assess to what extent, if any, Commission action may be appropriate to assure that customers are informed that such order restrictions can be imposed.
In summary, the unprecedented volume and volatility in the gold options market on September 28, 1999, strained the limits of the market’s capabilities and resulted in confusion and apprehension on the part of customers attempting to enter options orders or inquiring about fill reports. Floor brokers executed approximately 12 times as many trades for approximately eight times as many contracts as the market executed on an average day during 1999. Some orders that should have been executed were not. Reports of fills to customers were made late, or not made at all. Entry of transaction data into the Exchange’s On Line Trade Entry clearing system was delayed or in error and, as a result, there were exceptional numbers of unmatched and miscleared trades. During that week and the week that followed, customers encountered order restrictions that many of them did not realize could be imposed.
Nonetheless, FCMs interviewed by the Division agreed that gold options brokers generally performed acceptably under the circumstances of the day in executing as many orders as they could. FCMs did likewise. Further, several FCMs augmented their New York staffs, and all firms and brokers put in long overtime hours in order to respond to reporting and clearing problems caused by the volume of trading on and subsequent to September 28. FCMs responded to customer queries and, ultimately, resolved the great majority of customer complaints to the satisfaction of all parties involved.
The Exchange responded by increasing floor surveillance and by keeping the OLTE window open as late as possible in order to permit late submissions of trade data and corrections. Beginning on September 30, the Exchange restricted various floor members from trading in order to enable them to reconcile their previous days trading activity. In addition, Exchange staff met with various FCMs during the period after September 28. On October 14, in what the Division believes was a belated formal response, the Exchange sent letters to the nine clearing firms with the largest numbers of unmatched trades, to clarify the views and expectations of the Exchange with respect to the handling of miscleared trades and customer complaints.
Based on its analysis set forth above, the Division believes that various improvements could allow the Exchange and its members to eliminate confusion and reduce the severity and duration of problems if similar market conditions recur.41
First, the Division believes that Exchange data entry procedures and the data entry system could be streamlined. In this connection, the Division is aware that NYMEX plans to move COMEX clearing off of OLTE and onto the TMS by mid-2000. Nonetheless, certain aspects of the problems observed regarding data entry may be pertinent to TMS as well as OLTE, including inability to open the data entry system for input over a weekend.
Second, the Exchange should focus more attention on the problem of miscleared trades, which most FCMs and brokers identified as the major reason that it took so long to resolve trade data problems. The conversion of its data entry system from OLTE to TMS will not eliminate miscleared trades.
Third, the Exchange should consider implementation of additional automation, including both (a) order routing systems that can interface with TMS and (b) electronic deck management systems or other advanced technologies in this area that may be available or appropriate for development. Both would eliminate the requirement that executions be keyed in twice; once to report the fill via TOPS or proprietary order routing systems, and once to input the data into the Exchange’s clearing system. An electronic deck management system or similar technology would also automate prioritization of orders, and speed the receipt and execution of orders and the reporting of fills.
Based on its review, the Division recommends that COMEX take the following actions:
1. Continue efforts to adopt the TMS single-side clearing system before mid-2000 to replace OLTE, and ensure that TMS can be and is made available for data entry during special sessions, mandatory for all members and member firms, held (on weekends or otherwise) to resolve trade processing problems when necessary due to market events.
2. Give special attention to miscleared trades on high volume days, and develop a mechanism for gathering information in a timely manner on the extent and location of miscleared trades.
3. Adopt or encourage the use of both (a) an electronic deck management system or systems, or such other advanced technologies in this area as may be available or appropriate for development, and (b) an integrated data input system that would transmit a single entry of execution data both to TOPS or other routing systems for fill reporting purposes and to TMS for clearing purposes.
4. Develop and maintain an Exchange contingency plan in order to be better prepared for high volume events in the future.
5. Revise Exchange rules relating to not held orders, to clarify their form and define properly the characteristics of not held orders; and take appropriate steps to ensure that all Exchange members correctly understand the interaction of the Exchange’s fast market and not held rules.
1 The gold futures market also set a volume record on September 28, trading 187,427 contracts, an increase of one-third above its previous record of 140,726 set on October 24, 1997. The December 1999 contract rose $26.20 per ounce to settle at $310, after hitting a low of $295 on the opening and a high for the day of $329.
2 The six floor brokers interviewed included brokers who handle gold options business for FCMs responsible for major portions of gold options trading at COMEX, as well as brokers who handle small retail business. These floor brokers’ business practices were also representative of the various ways in which gold options brokers receive orders on the floor, including by telephone, electronic order routing systems, and electronic transmission over the dedicated wire system of an FCM. The six FCMs interviewed ranged from firms whose business involves execution of gold options trades for various types of participants, to firms whose business focuses primarily on clearing and guaranteeing floor brokers and locals. All firms interviewed were major participants on September 28, encountered difficulties with order execution and/or clearing, and, in most cases, were the subject of customer complaints and inquiries received by the Division. The Division’s interviews took place in November and December, 1999. The Division obtained additional data from the Exchange during January, 2000.
4 Source: Financial Times, Wall Street Journal, and CNNfn web page.
5 The gold futures market was also affected on September 27 by the announcement. December 1999 gold futures rose by $14 per ounce to settle at $283.80, after reaching a high for the day of $285.50.
6 Volatility on September 27 is illustrated by the December 1999 contract, the most active contract that day, which traded 14,718 contracts including 13,904 calls and 814 puts, 42.2 percent of the day’s total gold options volume. The most active of the December options contracts was the $295 strike call, which traded between premiums of $2.50 and $5, before settling at $3.60 per ounce, $2.80 higher than the previous day’s settlement.
7 Those FCMs and floor brokers who expressed opinions concerning why the largest market reaction to the central banks’ Sunday, September 26 announcement occurred on Tuesday, September 28, rather than Monday, September 27, felt that small retail customers acted on Tuesday because they only became aware of the bank announcement and its implications on Monday, or that perhaps they did not believe there would be a significant rise in the price of gold until they saw the market reaction by the close of Monday’s trading.
8 TOPS is a hardwired electronic order entry, routing, and fill reporting system that expedites the flow of orders from a firm’s desk, or directly from its customers, to its exchange floor operation. TOPS is jointly owned by the Chicago Mercantile Exchange and Chicago Board of Trade, and leased to members of other U.S. futures exchanges including COMEX. Most FCMs that transmit orders electronically to the COMEX gold options floor for execution use TOPS.
9 On September 27, 73 trades or approximately 0.83 percent of the 8,753 gold options trades recorded in OLTE were unmatched. As noted below, the average unmatched trade percentage at COMEX, based on September 1 through September 24, is approximately 0.18 percent. As also noted below, the unmatched trade percentage was to soar on September 28 to approximately 18 percent.
10 Between 78 percent and 92 percent of the September 28 trades entered into OLTE by each of the floor brokers interviewed by the Division consisted of one to five lot orders.
11 Of these brokers, 32 also traded in gold options for their own accounts at some point during the day.
12 The December 1999 options contract traded 26,438 calls and 8,325 puts on September 28, or a total volume of 34,763 contracts. This represented almost 43 percent of the total gold options volume that day.
13 COMEX Rule 4.68 – Fast Market Quotations: “Whenever the senior Exchange employee in a ring determines that the price fluctuations for a futures contract or futures option traded in the ring in which he is working are so rapid or the volume of trading in the contract is so large that (i) different prices are being bid and offered for the same delivery month or option contract month in different parts of the ring at the same time, or (ii) bids or offers are being made too rapidly to be reported fully, the employee shall transmit a ticker message and wallboard text stating the existence of a “fast market” by denotation “FAST” and the futures contract or futures option affected. During the fast market, all prices between ticker quotations shall be deemed to have been quoted on the ticker and wallboard. Upon determining that a fast market has ceased to exist, the senior Exchange employee in the ring shall transmit a ticker message and wallboard text stating the end of a fast market by denotation “END FAST” and the futures contract or futures option affected.”
14 One resulting problem was that when “cancel and replace” orders were received it was virtually impossible to determine whether the underlying order to be cancelled had in fact already been executed.
15 COMEX Rule 4.33 Priority of Orders and Allocation of Trades. “A floor member shall execute all orders by giving priority to orders in accordance with the time that orders are received by him at the ring and may not allocate trades among customers.”
16 As noted earlier, this had also been a problem on September 27. Some floor brokers told the Division that TOPS routinely malfunctions or experiences printing delays on busy days.
17 COMEX also had a higher than usual number of unmatched trades on Wednesday, September 29 (489 of 9,587 gold options trades, or approximately 5.10 percent), and this added to the cumulative unmatched trade problem that needed resolution.
18 COMEX Rule 4.13(c) Primary Clearing Member. “Each member desiring to execute transactions on the floor of the Exchange must be unconditionally guaranteed by a qualified guarantor which is the member’s Primary Clearing Member (“PCM”). In order to guarantee a floor member, the PCM shall: (1) agree to accept and clear all trades executed by the guaranteed floor member which are not otherwise accepted for clearance; (2) agree to accept financial responsibility for the trades held in an account in the record name and for the benefit of the guaranteed floor member which have been accepted for clearance by another clearing member authorized by the PCM to clear trades for the floor member pursuant to Rule 4.15(a), as long as the other clearing member has notified the PCM and the Exchange of any deficit in the guaranteed floor member’s account by 12:00 P.M. on the next trading day; (3) agree to accept financial responsibility for all trades adjudicated to have been executed by the guaranteed member, whether for his own account or for the accounts of others; (4) execute such guarantees and other documents as the Exchange shall require in connection with the PCM’s guarantee of a qualified floor member and shall file said documents with the Secretary; and (5) comply with the financial requirements for guarantors as set forth in Rule 7.03 (“Financial Requirements for Guarantors”).”
19 For an explanation of the PCM system at COMEX and its impact on the events of September 28, see the discussion below beginning at pages 25 through 29.
20 Floor brokers varied in whether they were able to get all their trades entered into OLTE prior to its shutdown on September 28. Some brokers interviewed by Division staff said they believed they had entered all of their trades; others reported that they were only able to enter as little as 20 percent of their trades before OLTE closed.
21 Generally, a broker is not held liable for the execution price obtained on an order which he accepts on a not held basis, unless it is determined that the broker did not use due diligence in filling the order. For a discussion of COMEX rules relating to not held orders, see pages 32 through 34.
22 COMEX Rule 4.87 Staff Authority Over Unmatched Trades. “Upon a determination by the President or any Vice-President that the number of unmatched trades either on the Exchange or with one or more clearing members is excessive, the President or such Vice-President may require, in order to aid in the timely submission of trade data and the resolution of unmatched trades: (a) that any or all floor members or clearing members be available and clearing members have an authorized representative available at the Exchange, on such days and at such times as may be determined by the President or such Vice-President, other than the hours for trading set forth in Rule 4.02(a) (“Hours for Trading”), and/or (b) that any or all floor members or clearing members have available on such days and at such times as may be determined by the President or such Vice President such duly authorized representative with the power and authority to make financial commitments on behalf of the member or clearing member, and such clerks and other personnel as the President or such Vice-President may deem necessary. Any floor member or clearing member that is the subject of such directive shall fully cooperate and comply therewith.”
23 COMEX Rule 4.86(b)(2) Resubmission of Data, known as the “four day rule,” provides that: “Trade data may be re-submitted to match an otherwise unmatched trade until the end of the corrections period on the fourth business day after trade execution, provided that such period may be extended by the Operations Committee if necessitated by data processing problems.”
One reason FCMs desired a weekend disaster recovery session following September 28 was that they feared, with respect to miscleared trades erroneously assigned to them for clearing, that after the fourth subsequent business day had passed, the firm to which the trade should actually have been assigned could cover its customer—by making a new trade and adjusting the customer for the difference if necessary—and then refuse to accept the original trade, leaving the first firm with the trade. However, according to the FCMs interviewed by Division staff, FCMs generally refrained from covering trades, and gradually resolved miscleared trade issues, even though this process took weeks to complete.
24 Some FCMs and floor brokers did come in over the weekend to work on clearing problems from September 28, but attendance was not mandatory and OLTE was not available for input.
25 The Division’s review of the Exchange’s Daily Brokerage Recap report for September 28 revealed that only four percent of the day’s trades (652 out of 15,044 trades) were trades which comprised 50 or more contracts and thus could be reasonably presumed to be institutional orders.
26 COMEX Rule 4.31 Dual Trading provides, in pertinent part, that: “Except to the extent provided in 4.31(b) (“Dual Trading-Permissible Transactions”), a floor member may not purchase any futures contract or futures call option or sell any futures put option in a commodity for his own account or for any account in which he has any direct or indirect interest while holding an order of another person for the purchase of a futures contract or futures call option or for the sale of any futures put option in the same commodity which is executable at the market price or at the price at which such purchase can be made for the member’s own account or for the account in which he has an interest.”
27 COMEX Rule 4.10 Recesses provides as follows: “The Chairman of the Floor Committee, with the approval of any member of the Board, the President, or any Vice-President, shall have the authority to order a recess or recesses during the trading hours of any one day which in the aggregate shall not exceed one hour in duration, during which trading in any futures contract or futures option shall be suspended, if in his opinion the volume of trading is so heavy as to make it desirable that floor members should be enabled to compare their records and verify trades in order to avoid confusion or errors at the close of the market. In the absence of the Chairman of the Floor Committee, any Vice-Chairman of the Floor Committee or any member of the Board Floor Group may act in the place and stead of the Chairman of the Floor Committee.” In addition, the Exchange has authority to suspend trading temporarily under the emergency powers provided in COMEX By-Laws, Article 7, Sections 701 and 702.
28 COMEX Rule 4.86(b)(1) regarding due diligence in resolution of trades provides that: “Each floor member and each clearing member shall exercise due diligence to resolve, prior to the opening of trading on the business day following trade execution, trades which are unmatched (trades for which the trade data submitted to the Exchange for the two sides of the trade reflect differences in commodity, delivery month and/or year, purchase or sale, price or premium, put or call, strike price, or executing broker) or which match but are otherwise unreconciled.” Resolution of all unmatched trades or all miscleared trades (trades “which match but are otherwise unreconciled”) from September 28 prior to the opening on September 29 was clearly impossible, as discussed below. The Exchange has taken no summary disciplinary action regarding failure to resolve such issues within one day, and the Division concurs that summary sanctions on that basis may be inappropriate given the circumstances.
29 COMEX Rule 4.82(c), which establishes a submission schedule for trade data, provides that all trade data shall be submitted within 30 minutes after the end of the half-hour Trade Execution Bracket in which a trade was executed. This was clearly impossible in the circumstances existing on September 28. The Exchange has taken no summary disciplinary actions regarding failure to meet this schedule on September 28, and the Division concurs that summary sanctions may be inappropriate given the circumstances.
30 As noted below, after top-day OLTE entries must be made by the FCMs that clear the two sides of the trade.
31 On Thursday, September 30, six floor brokers with large numbers of unmatched trades from September 28 were restricted from further trading until they cleaned up their unmatched trades, and on Friday, October 1, two additional floor brokers were restricted from trading for the same reason. By Monday, October 4, only one of the eight brokers was still restricted. According to Exchange staff, some brokers stayed out of the ring on October 4 at the request of their primary clearing members, or reduced the level of their own trading voluntarily, in order to work on unmatched trade resolution for September 28 and subsequent days. In addition to imposing these broker trading restrictions, the Exchange sent staff to ten member firms on September 30 to inquire concerning their unmatched trades, margin payments, and reconciliation reports relating to September 28.
32 COMEX Rule 4.86(a) regarding Rejection of Trades provides that: “Trade data for each trade shall be submitted directly to the clearing member intended to clear the trade pursuant to Rule 4.82(b) [where a clearing member rather than the floor broker inputs the required trade data into OLTE] or reported to the clearing member. If the data submitted or reported to the clearing member does not comply with the requirements set forth in Rule 4.82(a) or the account identification data is erroneous (i.e. is misnumbered or refers to an account which is not carried by the clearing member, to an account over which the floor member has no trade execution authority, or to an account for which the clearing member has advised the floor member, in writing, that trades may not be executed), the clearing member may reject the trade for clearance, provided that the clearing member so notifies the executing floor member within two (2) hours of receipt of the trade data from the floor member or report of the trade data by the Exchange or, in the case of data submitted after the close of trading in a particular market, within one (1) hour after receipt or report of the data.” Pursuant to this rule, when a trade reported to a clearing member during the day by the Exchange does not match the clearing member’s own records, the clearing member normally will make an intraday OLTE entry rejecting the trade as a “DK” or “don’t know” trade.
33 COMEX Rule 4.82(a) Submission of Trade Data. (a) General Requirements. “The following data shall be submitted for each trade executed on the Exchange: (1) all information recorded on a floor member’s trading card pursuant to Rule 4.80(b) and order tickets pursuant to Rule 4.81(a) and (b); (2) a customer type indicator . . . ; (3) the clearing member and account in which the trade will clear; and (4) such other information as the Exchange may require to match and/or clear a trade.”
34 For example, a ten-lot trade involving seven lots for clearing member “A” and three lots for clearing member “B” may have been assigned entirely to clearing member “A.”
35 COMEX Rule 4.82(f) Trade Allocation. “(1) If a member or member firm receives an order or series of orders which, if filled, either partially or fully, will require allocation of trades between or among multiple accounts, the member or member firm may input the data pertaining to the trade executions into a specially designated allocation account to facilitate trade check-out and data processing of such trades. (2) For purposes of compliance with the input schedule set forth in section (c) of this rule, if the member or member firm has not received specific allocation instructions prior to trade execution or the volume of orders required to be allocated is such that the member or member firm cannot input all data elements needed to separately identify each account for which trades were executed before the prescribed submission deadline, the member or member firm shall transmit the trade to the Exchange using an aggregate account identifier that will distinguish the trades placed in the allocation account from all other trades for which data is being submitted. (3) After initial input of data for the allocation account, the member or member firm shall input specific account identification for each contract purchased or sold. (4) If the member or member firm has not allocated a trade or trades held in an allocation account by the end of the correction period on the day of trade execution, the trade or trades shall be placed in the account of the executing floor member at his PCM.”
One clause in COMEX Rule 4.82(f) is inconsistent with Commission Regulation 1.35 and Appendix C to Part 1 regarding bunched orders in that it provides for situations where “the member or member firm has not received specific allocation instructions prior to trade execution.” Appendix C provides that a commodity trading advisor who bunches multiple orders for different accounts into a single order for placement and execution must identify those included accounts either prior to order placement (by prefiling a set of allocation procedures) or contemporaneously with order placement (by providing allocation instructions by phone or electronic transmission). Rule 4.82(f) is contrary to Regulation 1.35 insofar as it permits brokers to accept bunched orders without account identification and to place the fills from such orders in ALLO accounts. The Exchange plans to amend Rule 4.82(f) to delete this clause.
36 Because some brokers used ALLO on September 28 to expedite clearing of un-bunched orders, the Exchange plans to issue a written reminder to all members and member firms that Rule 4.82(f) applies only to bunched orders. The Exchange also advised the Division that it will consider whether Rule 4.82(f) should be amended to permit use of ALLO for un-bunched orders in extreme volume situations, such as occurred on September 28. To ensure that trades are processed out of ALLO as soon as possible, Exchange staff monitors on an intra-day basis the extent to which brokers use their ALLO accounts.
37 The information requested included reconciliation reports, outtrades listings, errors accounts, and customer complaint logs covering the period from September 24 through October 8, 1999.
38 An Exchange employee in the gold options ring declared a fast market at 8:20:01 a.m. The fast market continued until 1:10:43 p.m., started again at 1:18:37 p.m., and continued until the end of the trading session.
39 Rule 4.86 does not provide that when the fast market light is on, floor brokers are “not held.” Exchange staff emphasized to the Division that such an interpretation of the meaning of the fast market light and of Rule 4.68 is incorrect. As noted above, COMEX Rule 4.68 concerning fast market declarations provides that a “fast market” is one in which prices are fluctuating so rapidly or trading volume is so large that (1) different prices are being bid and offered for the same delivery month or option contract month in different parts of the ring at the same time, or (2) bids or offers are being made too rapidly to be reported fully. The rule therefore provides that during a fast market all prices between ticker quotations may have occurred. Nonetheless, as discussed earlier, conditions that give rise to a fast market declaration also can lead brokers to decide to execute orders on a not held basis.
40 See Commission Regulation 1.55(b)(2) and (b)(3), and Appendix A to Regulation 1.55(c).
41 The Division is not making any formal recommendations with respect to FCMs and brokers. FCMs and brokers interviewed stated that they were taking steps to implement several improvements, including the hiring of additional staff, the installation of additional printers, and modifications in internal procedures.